Itaú BBA - The Elusive Quest for Growth

Brazil Scenario Review

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The Elusive Quest for Growth

December 6, 2012

We have reduced our forecasts for GDP growth to 0.9% from 1.5% in 2012 and to 3.2% from 4.0% in 2013.

GDP disappointed in the third quarter and growth in 2012 and 2013 is bound to be weaker. More stimuli may follow, including lower interest rates 

We have reduced our forecasts for GDP growth to 0.9% from 1.5% in 2012 and to 3.2% from 4.0% in 2013. The negative surprise with GDP in 3Q12 and the expectation of slower expansion in capital expenditures have affected forecasts for growth this year and next. In a scenario of weak economic activity, we believe that the government will opt for lower interest rates and a weaker exchange rate to stimulate growth. We incorporated a 100-bp cut in the benchmark Selic interest rate in 2013 (ending the year at 6.25% vs. 7.25% in our previous call). Our year-end forecast for the exchange rate for 2012 was revised to 2.10 reais per U.S dollar and for 2013 moved to 2.15 (from 2.02 previously). We raised our estimate for the consumer price index (IPCA) for  2013 to 5.5% from 5.3%, considering a weaker currency and an increase in fuel prices, despite weaker activity. We revised our forecast for the trade surplus in 2012 to $19.5 billion from $20.5 billion, and to $20 billion from $18 billion in 2013, with the current-account deficit at 2.2% of GDP (from 2.3% previously) in the next year. We revised our forecast for the primary budget surplus to 2.3% of GDP from 2.4% in 2012 and to 2.1% of GDP from 2.2% in 2013.

Investment does not take off and GDP forecasts drop

GDP grew by only 0.6% qoq/sa in the third quarter, at half the pace that was expected. Previously it was the industrial sector which was not growing, now the service sector is the disappointing one. Private consumption remains solid, but the retreat in investments was sharper than expected, and exports and government spending were also weak.

With a disappointing third quarter and an outlook for tepid growth in the fourth, total growth in 2012 will be lower. The rebound which could have fostered more optimism, boosting business confidence, did not happen as expected. Worries about the future remain, leading to lower investments – and that will affect growth in 2013.
 

More stimuli are bound to be announced. In addition to more tax breaks, lower interest rates and a weaker exchange rate may be part of the toolbox in 2013, as was the case this year. Such stimuli may help the economy, but reducing domestic uncertainties in order to take advantage of incentives to growth is crucial, particularly in a still very uncertain world.

In the credit market, new consumer loans fell by 1.9% mom/sa in real terms in October, while new corporate loans retreated by 2.0%. Interest rates and spreads declined. Seasonally adjusted delinquency rates for loans more than 90 days past due are stubbornly stable at high levels. But the performance of new loans continues to suggest a drop in future delinquency.

Outstanding loans rose more strongly during the month (1.4%). Earmarked credit, particularly housing and farm credit, continues to take the spotlight. State-owned banks continue to increase their market share. Favorable conditions in the labor market and the expectation of lower delinquency suggest moderate credit expansion in the next few months.

Given the current outlook for economic activity, we cut our forecasts for GDP growth in 2012 and 2013. The expansion in 2012 was directly impacted by the weaker result in the third quarter. Signs for the fourth quarter already point to a more moderate expansion. We therefore lowered our forecast for GDP growth in 2012 to 0.9% from 1.5%.

The statistical carryover to 2013 GDP is declining. A more moderate expansion in the economy in 3Q12 and the pace expected for 4Q12 reduce the outlook for 2013. Furthermore, we believe that this uncertainty about the domestic rebound will have negative consequences for investment decisions. Therefore, we also reduced our forecast for GDP growth in 2013 to 3.2% from 4.0%, already taking into account the additional stimuli.

A weaker currency, but high FDI

After another quarter trading in the range of 2.01 to 2.05 reais per U.S. dollar, the exchange rate broke the dynamic of low volatility in November and reached over 2.11. Behind this move, there was an increase in global uncertainty, intensified by technical movements that are triggered when the exchange rate breaks certain levels. However, in contrast to what we have seen previously, the Central Bank acted in the market only at levels above 2.10 reais per dollar. Given weakness in growth and economic policy signals toward raising competitiveness through a weaker exchange rate, we revised our year-end estimates for the exchange rate to 2.10 reais per dollar in 2012 and to 2.15 in 2013, from 2.02 in both years.
 

In October, foreign direct investments (FDI) hit $7.7 billion, topping the most bullish of expectations. The current-account deficit, on the other hand, widened to $5.4 billion, due to a smaller trade surplus, more profit and dividend remittances and greater spending on international travel. For other flows, we continue to observe robust borrowing abroad and an outflow from the local stock market. We maintain our FDI forecast at $63 billion in 2012. Trade balance stood below our forecast in November. As a result, we revised downwards our projection to $19.5 billion from $20.5 billion in 2012.

A weaker exchange rate and lower economic growth impacted our forecasts for the trade and current account balances. Our call for the trade surplus in 2013 climbed to $20 billion from $18 billion, and our estimate for the current-account gap in 2013 slid to 2.2% of GDP from 2.3%.

Falling fiscal performance

Budget trends and outlook have changed little last month. Tax collection still loses steam, as activity remains sluggish and the impact of tax cuts begins to show. Moreover, federal spending is moving in high gear, at a pace of 6% from year-ago levels in the six months to October. The current speed of government spending exceeds estimates of potential GDP growth, which confirms an expansionary fiscal policy stance on the expenditure side.

The public sector's trailing twelve-month balance continues to downtrend. In October, it reached the lowest level since the end of 2011 (around 2.2% of GDP). Monthly budget results point to an increasing risk that the government will have to resort to deductibles on top of the 25.6 billion reais projected in the last budget review. For this year, spending on the PAC (infrastructure) program may deduct up to 0.9% of GDP from the 3.1% primary surplus target. We forecast a primary budget surplus of 2.3% of GDP for 2012 (previous forecast: 2.4%). Our estimate still counts on a temporary improvement in fiscal performance in the fourth quarter.

For 2013, we are revising down our primary surplus projection to 2.1% of GDP, from 2.2%. Signs of a slower than expected recovery, imply a less pronounced rebound in cyclical revenues (i.e., those strongly influenced by activity). A weaker tax collection reduces the room for future tax cuts, and limits somewhat the expansion of public spending (especially investment). According to our estimates, if the government maintains the fiscal target written in the 2013 Budget Law Guidelines (LDO) - allowing fiscal deductions of up to 1.0% of GDP in PAC expenses – there will be little room for additional stimulus. In this case, the decision to make is: more tax breaks or more public investment?

A weaker exchange rate and future fuel price increases maintain inflation high in 2013

We maintain our IPCA forecast at 5.5% in 2012. Current data indicate that the slowdown in food prices and the decline in agricultural prices have run their course. December data should already show more pressure on food prices at the retail level and a pickup in producer prices for agricultural items. According to our forecasts, market-set prices will rise by 6.2%, while regulated prices will increase by 3.4%. Among market-set prices, we expect gains of 4.3% for tradable goods and 7.9% for non-tradable goods.

We raised our forecast for the IPCA in 2013 to 5.5% from 5.3%. Even with the downward revision to our growth forecasts and more benign commodity prices, we anticipate high inflation due to a weaker currency and a possible 5% hike in gasoline prices next year, with a 0.2 p.p. impact on the IPCA.
 

We revised downward our forecast for the general price index (IGP-M) in 2012 to 7.5% from 7.9%, due to the postponement of fuel-price increases to next year. As a result, we revised upward our forecast for IGP-M in 2013 to 4.8% from 4.2%. We also took into account in this forecast the BRL depreciating to 2.15 at the end of 2013.

Interest rates: a change in direction, given headwinds to growth

The monetary policy committee (Copom) maintained the benchmark interest rate unchanged at 7.25% p.a. in its November meeting. The decision was unanimous and in line with our view and market expectations. The statement that accompanied the decision was the same as the one released in the previous meeting, in which the Copom indicated that the Selic rate will be stable for a “sufficiently prolonged” period (we dubbed it “flying at a cruise level”).

The signal shows confidence in a lower equilibrium real-interest rate, but also that current rates maintain economic stimuli. But we believe the cruise level of interest rates will be changed. There are now more headwinds to economic growth. We expect the Selic rate to go down again in March, with a 50-bp cut, and another cut of the same magnitude in the following meeting. Therefore, we expect the Selic rate to end 2013 at 6.25% (from 7.25% previously).



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